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A beginners guide

Our beginners guide to investing is a great place to start to help you learn the basics. Taking the first step can be daunting so we’ve created a simple 5 step guide so you can decide if investing is right for you.

Step 1: The basics of investing?

We all know it's a good idea to put some money away for a rainy day. An investment in its simplest form is when you buy something with the hope of it increasing in value. However, when you invest there are no guarantees and you could receive back less than you invested.

When you first decide to invest you don’t need to start with a large sum of money, just be comfortable with the amount of money that you choose to invest.

There are a number of different ways that you could choose to invest, including stocks and shares and funds. Investing in assets can have advantages over holding money in a bank account or cash savings.

Step 2: Why do people invest?

If you have savings and you’d like to see your money grow over the long term, then you could consider investing some of it.

You can also save for the future in cash accounts and the interest can also provide additional income. The downside to cash savings is that inflation can eat away at the value of your savings over time.

We show the possible impacts of inflation in the table below. Investing does come with greater risk than cash savings.

Average inflation

What £1,000 will be worth over time

Average Inflation

After...

2.5% inflation

5.0% inflation

7.5% inflation

10.0% inflation

After...

5 years

2.5% inflation

£884

5.0% inflation

£784

7.5% inflation

£697

10.0% inflation

£621

After...

20 years

2.5% inflation

£610

5.0% inflation

£377

7.5% inflation

£235

10.0% inflation

£149

After...

40 years

2.5% inflation

£372

5.0% inflation

£142

7.5% inflation

£55

10.0% inflation

£22

Step 3: What’s your reason for investing?

Invest for income

If you want to create income from investing one option is to choose investments that provide regular payments. For instance, shares pay a dividend and a bond pays interest.

Investing for income is popular with retirees who wish to supplement their pensions.

Invest for growth

Investing for growth is the aim of increasing the value of your investment known as capital gains. If you were investing in stocks and shares for example, growth would be the result of an increase in the price of the shares.

Compound growth

Compound growth can be defined when you re-invest dividends which can generate extra earnings over time. The asset accumulates growth from the original investment and the added earnings are known as compound interest.

Most investors will invest for both growth and income, for example an income investor could use the income from their investments and reinvest this with the aim of generating, and a growth investor might sell their investment to gain an income.

Step 4: Your Investment options

Shares

When you purchase shares you’re buying a stake in a company. Shares are traded throughout the day on the stock exchange and the price can go up and down.

Pros: Capital gains

If you choose your stocks and shares wisely they could rise in value over time. Shares have generally provided better returns than cash if you're investing for a longer term, although this isn't guaranteed.

Cons: Capital losses

If you were to invest a company that isn't growing in value then the share price could drop. This can result in a loss of money to your investment.

Funds

A fund is a collective investment which means your money is spread over a range of different markets, unlike a share when you own a slice of a company. Funds are managed by a professional Fund Manager who decides on where to invest your holdings. With funds you buy units which can either increase or reduce in price.

Pros: Diversification

Funds spread their holdings across a number of different sectors, markets and stocks which can reduce the risk. If one holding performs poorly over a certain period, then you have a chance of other holdings performing better which can reduce the potential losses to your investment portfolio.

Cons: Liquidity

A fund manager might need to sell holdings to pay investors who are withdrawing the fund. If the asset is difficult to sell like property then this can result in delays in receiving your money back.

Exchange Traded Funds (ETFs)

Exchange Traded Funds trade on a stock exchange like shares. However, unlike shares which are focused on one company, ETFs track an index, commodity, sector or currency and invest in a range of assets with an aim of closely tracking the performance.

Pros: Lower fees

Benefits of an ETF are its cost effectiveness. They offer lower fees than managed funds due to lower operating costs.

Cons: Performance

ETFs track a market unlike funds which are actively managed and try to outperform the market. This can impact the performance.

Investment Trusts

An investment trust is a company that raises money through selling shares to investors which then pool the money to purchase and sell a range of investments. Investment trusts can vary with different aims and mixes of shares and assets.

Pros: Liquidity

Investment trusts don't need to sell the assets when an investors exits the fund, which means investors can sell their holdings more easily on the stock market. The price of an investment trust can could reduce when more units are sold than bought.

Cons: Potential Price Volatility

The price of an investment trust can be influenced by the demand for the share. In a scenario where investors don’t feel the investment trusts is being managed as well as expected then this can impact the price when investors want to sell rather than buy.

Bonds and Gilts

Bonds and gilts are a way for companies or governments to raise money which is done by borrowing money from investors. When you invest in a bond or gilt you’re lending money to a company or government which in return provides a fixed rate of interest.

Pros: Stability

Bonds and gilts have lower risks than stocks and have the potential to provide a more stable return over time.

Cons: Growth Potential

The drawback of bonds and gilts is that they don’t provide higher long term returns compared to other stocks. Bonds and gilts can be impacted negatively by changes to interest rates, economic uncertainty and currency fluctuations.

Discover our boost your skills articles which have been created to help you with your investment knowledge.